派克漢尼汾 (PH) 2003 Q2 法說會逐字稿

Good morning and thank you all for holding. Welcome to Denison International's second-quarter 2003 earnings conference call. At this time, I'd like to inform all parties that your lines will be placed in a listen-only mode until the question-and-answer segment of today's call. I would also like to inform all parties that this call is being recorded at the request of Denison International and its legal counsel. If you have any objections, you may disconnect at this call time.

Before beginning today's call, the management and legal counsel for Denison International have asked me to remind you that certain statements they may make today could be considered forward-looking statements and that you should refer to the company's SEC filings and press releases for further information concerning forward-looking statements.

For today's call, David Weir, Denison President and CEO and Bruce Smith, Denison Chief Financial Officer, will conduct the Q&A session to answer any questions that you may have.

I would now like to turn the call over to this morning's conference leader, Bruce Smith. Go ahead.

Good morning, everyone. Welcome to our second-quarter teleconference call. Hopefully, everyone has had a chance to read the press release. We will continue with our normal format and I will turn it over to David with a summary of our quarter and year-to-date results.

Thanks, Bruce. Good morning, everyone. We had a very good first quarter to the year and (indiscernible) with favorable that it would continue in a fairly good fashion, and that's what we saw in the second quarter, a very solid quarter.

Sales revenues, $46.4m, were a new record for the company, helped very much by the exchange rate movement of the dollar. They were up 17% over the same period last year. 2.5% of that was volume and the rest was due to currency. Gross margins stayed consistent from last year; 35.5%, which is very good because there's an awful lot of price pressure out there in the market. Pretax earning of $5.1m was up nearly 19% over last year.

The tax rate also increased to 26% over 21% last year. That's with a little bit of a (indiscernible) to the net, which ended up at $3.8m, or 10% over last year. So basic and diluted earnings per share came out of (ph) 38 cents per share versus 32 last year. That is an increase of 18-3/4%. That builds on the very good first quarter that we had.

So we have now at the half-year, almost reached $91m in sales revenue, which is 17% up 2.5 (ph) due to volume, and the rest coming from currency. Gross margins inched up a fraction to 35.9% and pretax profits, $10.4m compared to 8.6 last year. It's an increase of 21% before the accounting adjustment that we had last year. Tax rates moved up, as I said, so we get to a net of $7.5m versus $6.4m last year. That makes earnings per share 75 cents for the half-year, which compares to 59 cents last year, if we put in on the same accounting basis and we take that FAS-142 adjustment out.

On the balance sheet side, I think continues to be very strong. Net cash after deducting borrowings increased to $47.6m, which is almost $4 a share for the shares outstanding. From operations, we generated $7.3m in the quarter, a very strong and picked up another $2m from the currency change.

Inventory levels have reduced, even volume turns. They remained flat in valuation, despite the currency impact, so that is very stable position. And incoming orders for the quarter, which is always an indication of where we're going next, were up 21% over the same quarter last year. That is 6.5% of that is due to volume.

Sequentially, orders increased 4% over Q1 this year where currency is not really a factor. The backlog moved up to 33m at the end of the quarter, compared to $30m for the quarter before and $29m at the same time last year. So generally, all things moving in a fairly positive direction. You may have noticed the operating expenses year-to-date were up about $3.3m in total. .

Currency accounts for about $2.7m of that and Rander, which was an acquisition we just did in June of 2002, makes up another million of that increase. So overall, our rate of SG&A as a percent of sales has remained constant at 24.7%, but the dollars were up.

You may have also noticed that we have had another expense item year-to-date of roughly $100,000, and that's a requirement that we reveal our intercompany loans on a current currency basis at the end of a period. As currency fluctuates, that number may go up or down in subsequent quarters, but it really relates to just those intercompany loans. Our tax rate year-to-date is 28% versus 25.8% last year. I

If you remember in 2002 in the second quarter, we were required to book some deferred tax assets in our German operations that arbitrarily reduced our effective tax rate, but no such items are in this year. So that's why the increase is on that line item.

Once again, as has been historically, the dilution of our shares is very small, only 32,000 shares, about 3/10ths of 1%, so it is never a factor that we have had here at Denison and continues to be such. Capital expenditures year-to-date are $2.3m, about $1.7m less than last year. We should see over the run rate we have had an increase in the third quarter due to some spending, as plant shutdown will begin the Tampere, Finland expansion project. We're still looking for our full year estimates for the year to hold true. There should not be any big difference there.

As David said, the balance sheet remains strong. The only other item, our day sales outstanding on receivables are 81 as of June 30, 2003, versus 80 at the same period last year. So no real change in our receivables. We're keeping a pretty tight watch on that, based on economic conditions around the world to make sure that we keep that number in line and we were successful in doing that and we will continue to manage that number.

David will have some more geographic detailed results for you now.

Thanks, Bruce. Let's start with North America first.

Sales revenue quarter was flat with last year and with the year-to-date, showing a slight gain of 1.6%. Incoming orders in the quarter were down 3%, but they're up 5% year-to-date. It is still a very weak marketplace.

Industry figures in competitors' results (indiscernible) a drop of between 5% - 8% in the North American fluid power market, compared to last year. For Denison, that weakness is showing itself in OEM sales. Bigger OEM sales were down 13% in the quarter and 10% year-to-date. That just indicates weakness in the end markets that they serve. It's construction equipment, cranes, refuse trucks, die casting machinery, drilling equipment. Most of those are having a pretty tough time in the marketplace at the moment.

But on the other side of things, distributors are holding up quite well. They were up a modest 1.6% in the quarter and 8.6% year-to-date. And their inventory levels have remained stable, but at a very low level. I was a little concerned at the low-level of their inventory at the end of last quarter and it stayed exactly at that level. So everything we shipped to them this quarter has gone out to the customers.

Profitability overall in North America is running cents a share ahead of last year, despite a higher tax rate. Pretax earnings remain 51% ahead of last year, but still a very delicate marketplace indeed. Very much a month-to-month picture when we look at the results.

If we look at Europe, we have had an awful lot of help from the currency, which I will be quick to point out is only reversing the negative trend we experienced over the last five years. Sales revenue for the quarter were up 29%, 5% of it due to volume, the rest from the exchange. Incoming orders up a very healthy 40%, again, with a large amount of help from the exchange. The weaker dollar had a good effect on the profits for the quarter from Europe. We showed a 24% increase in pretax profits, although the net only increased by 3 cents a share because of an increase in the effective tax rate.

Most countries reported better results than last year, particularly France, with some good success in systems sales and England, who are benefiting from the forestry industry that is rebounding quite nicely. We still see depressed there in the plastics business, die casting, refuse, trucks and some of the other traditional Denison markets.

Year-to-date, though, it is still a good picture. Sales revenue is up 27%, 5% due to volume, and incoming orders up 35%. Year-to-date net income rose 16%, but this was all due to the currency. Last year, exchange rates profits were fairly flat with last year. The weakened U.S. dollar makes the U.S. manufactured product particularly distant (indiscernible) cheaper in Europe. Price competition in the market remains very fierce, as fierce as I have known it, and so we have not yet seen any increase in the margins coming from Europe as a result of that currency change.

In Asia, a little off of the (indiscernible) here due to recent events. Sales revenues rose 6.4%, but it was all due to foreign exchange, flat in volume terms. Incoming orders fell 2.3%, and that was actually a decline of 8% if we do it in volume terms. For the quarter, profits rose 10%, but the net fell slightly because of the higher tax rates. Profits in Japan rose due to improved margins and cost cutting. There are no real signs of a large recovery in Japan yet.

But profitability fell in China with SARS and the slowing down the economy there. Incoming orders in China fell 28% from last year's levels. Year-to-date in Asia, we're up 6.5%, but it's flat in volume terms and I think we're looking forward to that part of the world getting back on its growth track. It has been probably the best area for growth we have had over the last few quarters and it has got knocked off the rails a bit with SARS. So I'm looking forward to that path getting back on track.

So I would say overall, it is a good first-half, one of the stronger ones that we have had. Incoming orders and backlog look good, but I have to say that the market is still very tight. A lot of pressure on margin. All our factories are running with four to six week backlog, which has almost become standard operating procedure now, but it does leave (indiscernible) very vulnerable to any short-term change in the (indiscernible), the factories carry a high fixed cost with them. If they see a temporary interruption to volume, it gets down to the bottom-line very quickly. The balance sheet goes from strength to strength with net cash looking almost at $50m now. A healthy picture as good as we can expect in such a tight market.

With that quick summary, I will open it up to questions.

Eli Lustgarten, H.C. Wainwright.

Good afternoon gentlemen, or good morning. Interesting quarter. What is the tax rate for the rest of the year going to look like?

We normally go up slightly in the last two quarters, Eli. (Technical difficulty) probably be running 29-30% in the third and fourth quarter. Probably, if I would look at it right now, ex any law changes, we will be in the 29-ish% rate for the full-year, I would estimate by the time we get there.

Similar next year, I assume, right?

Nothing on the shelves, as far as litigation that I know of, and we still do have the NOLs in Germany through next year. So we should be about the same level.

Can we talk about the second half? I mean this quarter had a disappointing domestic profitability. And Asia was under pressure. Are we looking -- 37, 38 what we looking at in the second half? Couple of pennies lighter than the first-half at this point?

I don't know, Eli.

I know it's tough; we're all having trouble.

It is tough, and the third quarter in particular is always the more difficult one to forecast. The order book looks good and strong. The currency looks quite strong. I think we are still on track to get in our 145, 155 band (ph) for the year.

But you know we've seen the euro go from 118 to 112, 113.

Of course, I don't know how anyone can predict that, but that does have a big effect on the results.

Eli, through the first six months, because of the way we calculated, the average euro was about 110 in these results, so we are still ahead.

Slightly positive -- I don't have to worry about it?

If we don't see a real dip-down of it, there will be some additional incremental benefit as we get into the third and fourth quarter. But as David said, who knew it would be 118 and whoever thought it would be 182? So it is anybody's guess.

(indiscernible) big part of the margins got clipped again in North America in the second quarter. Are we looking at a tough third quarter in North America also?

It will be tough, I'm sure. I think you're probably comparing to the first-quarter, aren't you, Eli?

Well, no matter how I compare it, first quarter you go from 10 to 4.6 (ph) and year-over-year, it is still 5.8 to 4.6 (ph).

First quarter we had last year was quite exceptional. Of course, this year was quite exceptional, 10.5% pretax profit was very good. We're still doing 5.5% pretax profit. One of the factors that has hit the North American business this quarter for the first time is that currency effect. We'd had a forward contract in place that protected business for the first quarter of this year, but that is now expired.

At current business levels, that is a cost of between 30 and $40,000 a month. We're going to see that sort of the balance of the year at these currency rates. The business traditionally slows up a little in the third quarter. We have seen some readjustment by OEM customers. I think that is probably over now. I think we won't sustain the margin level of the same level as we have seen, unless where we're lucky on product mix, simply because of the increased costs of the imported product, but I think we will stay fairly well up there and I'm still feeling fairly good about the results for the year, Eli.

Can you make more money in the third quarter than the second quarter in North America?

Not usually. Worldwide, it is usually the low quarter out of the year.

Yes, but in the third quarter, because you had a very good quarter last year also.

Yes we did, and it is always difficult to compare those. If you look at the profile of last year, it was quite different to this year. We started off at a very, very low-level and then started to pick up speed as we went through. We have come off of more steady but still depressed levels this year, nothing such a recovery situation as we were last year, so that is use (ph) it a little bit. I still think we will see a fairly solid result out of North America.

But that's probably very similar to the second quarter?

Yes.

You had a corporate positive income contributing in the second quarter?

As our plants sell to the sister companies, Eli, we have to defer the profit to the inventory levels change and we record that intercompany profit, plus or minus as a corporate item.

Are we going to see that in the third quarter too, or does it go back to a slight negative again?

No. There will be some in the third quarter only because the inventory levels have come down somewhat because of the plant shutdown. So we will be working through some of the inventory at the sales locations. So there will be an amount in the third quarter. I don't know how much it will be compared to the 362 we have right now, but if the inventory levels behave like they usually behave in the third quarter, we will see some money there.

So, it will be a positive number?

Yes. I can't imagine we will have to defer any, based on the plant production on the plant production and the shutdowns in Europe?

The same thing in the fourth quarter, amortize positive number?

Could be. It depends on production and what will happen there but it will probably be, if it is a positive number in the fourth quarter, it will be a slight positive.

In both cases. All right I will let someone else have a crack at it.

Thank you, Eli.

Rick [Dontal], Columbia Management.

Good morning guys. One thing you didn't mention, we're sitting with a lot of cash -- I know the buyback program is still in force, although you said you did not do anything in the quarter. One, what are your thoughts on that? And two, what does the acquisition environment look like right now?

I can answer the acquisition one first and there's not much activity likely to take place. We haven't got anything in any advanced stages at this point. And as regard to the cash, I guess it is better to have it than not to have it. We are accumulating and we have said we would use if for acquisitions or buying our own stock but the price of the stock went up quite nicely and that has slowed down our activity for buying stock.

Okay. So there's just not much going on out there in the seller universe or?

Not particularly, no; not that we're interested in.

All right, thanks.

Ed [Leverman], First Manhattan.

Hi, good morning. Just one question. I see your free cash generation in the quarter was $9m. So obviously, you're still generating a lot of cash out of working capital. I'm just wondering how much more you think that can go second half or next year?

On the second half, Ed, we will have more Capex in the third quarter and it is a slower quarter for us sales-wise. I would not be surprised, we could get to a $55m level by the end of the year. We normally generate $12m - $14m of positive cash flow in the company after Capex. So next year or by the end of the year at December 2004, barring any acquisitions or share or buybacks, that number could be in the $67m - $70m range.

We're doing a very good job on inventory at the moment. I think if we see the volume pick up, and I would love to have that problem, we may have a bit more money back into the inventory.

It looks like even if you take out the cash, you still have a very strong working capital position. I don't know how much of that is considered excess yet or, if any?

Probably don't consider a whole lot of it excess at this point in time. It is difficult -- when you go into the third quarter, it is a little bit usually slower business activity. But by the time you get to the end of the year, I wouldn't consider a whole lot to be excess.

Just refresh my memory -- what is your capital spending forecast for the full year?

$6m - $7m. As I said, we will do more in the third quarter normally with the plant shutdowns and what have you. Some of the projects will kick off. Right now, we would be closer to $6m and $7m. That's the way we're feeling right now. Depreciation for the year will be about $6.5m. So we will be right at or slightly below depreciation, as far as Capex goes.

Where would your guess on capital spending be for next year?

We are finishing up the expansion in Bologna and we're starting an expansion in Tampere, Finland. We don't have really any other plans for any other plant expansions. So I would say probably for next year, somewhere in that $6m range, barring any new projects that come up between now and then that are a good idea to do. So we will be for this year and next year, probably at or below depreciation on capital. It is kind of cash flow neutral.

Great, thanks very much.

Jim Bong, (indiscernible) & Company.

Good morning. Could you talk about your pricing pressure, what you're seeing in terms of what specific market? And would you be able to (indiscernible) operating margin rates in the second half with the pressure you see?

First question, we're seeing it everywhere, we're seeing it all around the world. One competitor, in particular, is being very aggressive on price, and that obviously has an effect on us in some cases. We walked away from business rather than go down there on price. I think we will see margins fall a little, certainly North America, because we have lost that currency coverage and it is costing more to import the European product. But, we do have the opposite effect going in Europe where the American product becomes a bit cheaper.

We haven't seen much benefit of that at the moment due to the pricing pressure, but at least it has helped us maintain the margins. So it is very complicated because you have a mix of customers and a mix of products to throw on top of all of the economic factors. I would think a slight decrease in margins in the second half of the year.

Okay. In your press release, you commented on your outlook for Asia-Pacific. And I guess in the call, you touched on a little bit about North America has been pretty much the same. How about Europe? Do you want to just comment a little bit in terms of what your outlook is for Europe for the second half?

I'd say it's slightly better in Europe. It's a more diverse place. The outlook, certainly looking at our internal reports in northern Europe is fairly good. Their incoming orders and business positions are all quite encouraging in most of the countries there. In southern Europe, they have a lot more reliance on certain industries, particularly the plastics business, which has been quite a depressed business for a good while.

They don't have any reason to feel any better about their plastics. But I'd say the outlook in Europe -- slightly better. Certainly, the fact that the U.S. product is cheaper should be helping them a little bit, at least even if it helps them match the tough market conditions. Probably the place to look the most for the profitability improvements in the second half of the year.

Okay, thank you.

Gentleman, at this time, we do not have any further questions. I will turn the call back over to you for any closing remarks.

Okay, well, thank you very much. Hopefully we will keep this momentum going and talk to everybody next quarter.